A diversified but expensive approach to managed futures.
Before the launch of the first managed-futures mutual fund in 2007, investors could only gain access to managed futures through commodity pools or separate accounts, managed by entities called commodity trading advisors. These pools or separate accounts often had large minimum investment requirements and frequently required an investor to be accredited. The proliferation of alternative mutual funds in recent years has enabled any individual investor to gain access to these CTAs. The first launched at the end of 2009 as a fund of multiple CTAs. Since then, at least nine other multi-CTA funds have launched, along with six single CTA funds.
In this article, we examine the four biggest multi-CTA mutual funds under our coverage (Altegris Managed Futures Strategy
The Value of a Multi-CTA Fund
A multi-CTA managed-futures fund can provide value to investors in a number of ways. First, compared with a commodity pool or separate account CTA investment, a multi-CTA mutual fund avoids the high investment minimum and net-worth requirements. Second, a multi-CTA fund manager opens separate accounts with the underlying CTAs and has control of the assets, unlike in a commodity pool. The manager also typically conducts extensive due diligence when selecting the CTAs, in order to further reduce operational risk. Third, a multi-CTA fund has the ability to diversify among several different futures trading strategies, while most single-manager managed-futures mutual funds are pure trend-followers. And finally, a multi-CTA fund manager can add value by over- and underweighting the various CTA strategies based on his judgment of market conditions.
Despite these merits, multi-CTA strategies also carry unique risk factors. When considering investing in such funds, investors should pay special attention to transparency, CTA and strategy overlap, and fees.
A multi-CTA mutual fund has to set up an offshore entity in order to invest in the underlying CTAs (because of arcane tax laws that treat commodity exposure in mutual funds as “bad income”). According to current SEC regulations, activities within the offshore entity (that is, information about the underlying CTAs and their investments) are not required to be disclosed. However, some firms choose to be more transparent than others. Transparency plays a major role in fund evaluation and could also serve as an important sign of investor-friendliness.
Altegris and MutualHedge provide investors with the most comprehensive information on underlying CTAs, such as the firm names and manager backgrounds, the track records of the CTA programs they invest in, and the percentage allocation to each CTA. Grant Park only shows the names of its underlying CTAs. And investors can’t find any specific information about underlying CTAs on the Princeton fund’s website. It’s difficult to have confidence in an investment when one has no idea what he is invested in.
Table 1: Transparency of Multi-CTA Managed-Futures Funds
CTA and Strategy Overlap
Although the CTA universe is huge (Morningstar’s database tracks more than 400), multi-CTA mutual funds appear to have a large overlap among the CTAs they select. A few large and established CTAs hold places on almost every multi-CTA fund’s portfolio, such as London-based Winton Capital Management, which is specialized in systematic trend-following strategies, and Quantitative Investment Management, a U.S.-based CTA focused on short-term pattern-recognition models. (See Table 2).
Table 2: CTA Overlap*
In terms of strategy allocation, multi-CTA funds do not deviate from each other too much either. All four dedicate at least 44% to price-trend-following strategies. (Princeton does at least disclose strategy allocations.) In each case, the remainder of the portfolio is typically diversified among strategies such as countertrend and global macro. (See Chart 1.)
Chart 1: Trend-Following Exposure Among Multi-CTA Funds*
*Altegris, MutualHedge, and Princeton are based on July 2012 allocation. Grant Park is based on October 2012 target allocation.
The overlapping strategies mean high correlations among the multi-CTA funds. (See Table 3.) Still, the non-overlapping part of the portfolios coupled with management’s ability to adjust CTA allocations play a large role in performance. For example, from March 2011 (Grant Park’s inception) to August 2012, Grant Park and MutualHedge significantly outperformed Altegris and Princeton. (See Chart 2.) Therefore, it is important to examine the full strategy lineup and management’s allocation methodology.
Table 3: Correlations Among Multi-CTA funds 3/6/2011 to 8/25/2012 (weekly data)
Chart 2: Multi-CTA Growth of $10,000 3/4/2011 to 8/29/2012
Access to CTAs does not come cheaply. Even though CTAs’ strategies are offered in mutual funds, they still charge hedge-fund-like management and performance fees. This makes CTA-based managed-futures funds the most expensive type of mutual fund. (Mutual funds cannot charge performance fees, but these funds’ CFC structure allows them to).
It is tricky to analyze the fees for multi-CTA managed-futures funds because they are linked with fund performance. The annual report’s net expense ratio will be higher if the underlying managers experienced good performance. Nevertheless, the prospectus does report the range of average of the underlying management and performance fees charged. And by the end of this year, the fees will be even more transparent as the CFTC (which also regulates CTA-based mutual funds) will require a “break-even” calculation in the prospectus.
Table 4 lists the net expense ratios, along with a breakdown of the underlying management fees and performance fees for each of the four multi-CTA funds, as reported in the most recent prospectus. MutualHedge sports the highest total net expense ratio (5.95%), mainly because of the hefty performance fees paid out to underlying CTAs; it was the only multi-CTA mutual fund with a positive 2011 return (1.73%). Princeton delivered the worst performance last year (down 7.99%), and it also charges the highest management fee (1.8%) among the four.
Table 4: Multi-CTA Funds’ Fee Breakdown (A share)
In conclusion, investors should demand high transparency in order to conduct a full evaluation on CTA selection and allocation methodology before agreeing to pay the hefty prices for multi-CTA managed-futures mutual funds.